BOND BASICS FOR BEGINNER

PROVIDED BY BAYAREADRE
What are they,
why are they important,
why do I need them,
how are bonds sold/on the market
PREMISE: Would you call yourself an investor, if yes, wouldnt it be important to understand
how an investor protects his assets? Assets
The problem large organizations run into is that they typically need far more money than the average bank can
provide. The solution is to raise money by issuing bonds (or other debt instruments) to a public market. Thousands
of investors then each lend a portion of the capital needed.
A bond is nothing more than a loan for which you are the lender. (Think of a bond as an IOU given by a borrower
(the issuer) to a lender (the investor))
The organization that sells a bond is known as the issuer.
The issuer of a bond must pay the investor something extra for the privilege of using his or her money.
The interest rate is often referred to as the coupon.
The date on which the issuer has to repay the amount borrowed (known as face value) is called the maturity date.
Bonds are known as fixed-income securities because you know the exact amount of cash you'll get back if you hold
the security until maturity.
(For example, say you buy a bond with a face value of $1,000, a coupon of 8%, and a maturity of 10 years. This
means you'll receive a total of $80 ($1,000*8%) of interest per year for the next 10 years. Actually, because most
bonds pay interest semi-annually, you'll receive two payments of $40 a year for 10 years. When the bond matures
after a decade, you'll get your $1,000 back.)
Debt Compared to Equity
Bonds are debt, whereas stocks are equity. This is the important distinction between the two securities.
By purchasing equity (stock) an investor becomes an owner in a corporation. Ownership comes with voting rights
and the right to share in any future profits.
By purchasing debt (bonds) an investor becomes a creditor to the corporation (or government).
The primary advantage of being a creditor is that you have a higher claim on assets than shareholders do: that is, in
the case of bankruptcy, a bondholder will get paid before a shareholder.
The bondholder does not share in the profits if a company does well - he or she is entitled only to the principal plus
interest. There is generally less risk in owning bonds than in owning stocks, but this comes at the cost of a lower
return.

Characteristics
Bonds have a number of characteristics of which you need to be aware. All of these factors play a role in
determining the value of a bond and the extent to which it fits in your portfolio.
Face Value/Par Value
The face value (also known as the par value or principal) is the amount of money a holder will get back once a
bond matures. A newly issued bond usually sells at the par value.
The par value is not the price of the bond. A bond's price fluctuates throughout its life in response to a number of
variables (more on this later). When a bond trades at a price above the face value, it is said to be selling at a
premium. When a bond sells below face value, it is said to be selling at a discount.
Coupon (The Interest Rate)
The coupon is the amount the bondholder will receive as interest payments. It's called a "coupon" because
sometimes there are physical coupons on the bond that you tear off and redeem for interest. However, this was
more common in the past. Nowadays, records are more likely to be kept electronically.
Most bonds pay interest every six months, but it's possible for them to pay monthly, quarterly or annually. The
coupon is expressed as a percentage of the par value. If a bond pays a coupon of 10% and its par value is $1,000,
then it'll pay $100 of interest a year. A rate that stays as a fixed percentage of the par value like this is a fixed-rate
bond. Another possibility is an adjustable interest payment, known as a floating-rate bond. In this case the interest
rate is tied to market rates through an index, such as the rate on Treasury bills.
Maturity
The maturity date is the date in the future on which the investor's principal will be repaid. Maturities can range
from as little as one day to as long as 30 years (though terms of 100 years have been issued).
Issuer
The issuer of a bond is a crucial factor to consider, as the issuer's stability is your main assurance of getting paid
back. For example, the U.S. government is far more secure than any corporation. Its default risk (the chance of the
debt not being paid back) is extremely small - so small that U.S. government securities are known as risk-free
assets. The reason behind this is that a government will always be able to bring in future revenue through taxation.
A company, on the other hand, must continue to make profits, which is far from guaranteed. This added risk
means corporate bonds must offer a higher yield in order to entice investors - this is the risk/return tradeoff in
action.
Measuring Return With Yield
Yield is a figure that shows the return you get on a bond . The simplest version of yield is calculated using the
following formula: yield = coupon amount/price. When you buy a bond at par, yield is equal to the interest rate.
When the price changes, so does the yield.
Let's demonstrate this with an example. If you buy a bond with a 10% coupon at its $1,000 par value, the yield is
10% ($100/$1,000). Pretty simple stuff. But if the price goes down to $800, then the yield goes up to 12.5%. This
happens because you are getting the same guaranteed $100 on an asset that is worth $800 ($100/$800).
Conversely, if the bond goes up in price to $1,200, the yield shrinks to 8.33% ($100/$1,200).
























Definition of 'Interest'
1. The charge for the privilege of borrowing money, typically expressed as an annual percentage rate.

2. The amount of ownership a stockholder has in a company, usually expressed as a percentage.

Interest is commonly calculated using one of two methods: simple interest calculation, or compound interest
calculation.

Investopedia explains 'Interest'
1. Lenders make money from interest, borrowers pay it.

2. Someone who holds more than 5-10% of the stock in a company is said to hold significant interest.

Definition of 'Security'
A financial instrument that represents: an ownership position in a publicly-traded corporation (stock), a creditor
relationship with governmental body or a corporation (bond), or rights to ownership as represented by an option.
A security is a fungible, negotiable financial instrument that represents some type of financial value. The company
or entity that issues the security is known as the issuer.
For example, the issuer of a bond issue may be a municipal government raising funds for a particular project.
Investors of securities may be retail investors - those who buy and sell securities on their own behalf and not for an
organization - and wholesale investors - financial institutions acting on behalf of clients or acting on their own
account. Institutional investors include investment banks, pension funds, managed funds and insurance
companies.
Investopedia explains 'Security'
Securities are typically divided into debt securities and equities. A debt security is a type of security that represents
money that is borrowed that must be repaid, with terms that define the amount borrowed, interest rate and
maturity/renewal date. Debt securities include government and corporate bonds , certificates of deposit (CDs),
preferred stock and collateralized securities (such as CDOs and CMOs).

Equities represent ownership interest held by shareholders in a corporation, such as a stock. Unlike holders of debt
securities who generally receive only interest and the repayment of the principal, holders of equity securities are
able to profit from capital gains.

In the United States, the U.S. Securities and Exchange Commission (SEC) and other self-regulatory organizations
(such as the Financial Industry Regulatory Authority) regulate the public offer and sale of securities.
A secured creditor holds a special legal right in particular property of the debtor to assure him or her of repayment
of the debt. A creditor who has the protection of a lien or mortgage is secured.


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